Oil and Gas: The Persistent Role for Fossil Fuels

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Oil and Gas: The Persistent Role for Fossil Fuels

Disclosure

This podcast is for general information purposes only and is
not advice. Outside of the United States this episode is intended for
investment professional use only, not for further distribution. Please listen
to the end for complete information.

Cold open: “Supply and demand explain the noise.
Productivity and cost curves explain the music, and the real alpha comes from
knowing which one you're listening to.”

Jackie Fortner

Welcome to “The Angle from T. Rowe Price”, a podcast for
curious investors. I'm your host, Jackie Fortner, a portfolio specialist at T.
Rowe Price Associates here in Baltimore. This season, we're exploring the
rapidly evolving global energy landscape and whatthe future might hold for
investors, innovators, and policymakers alike.

In today's episode, the first of the new season, we're
diving into the heart of the energy complex with the discussion on oil and gas.
These commodities create the energy that powers the world. And as we'll see
this season, will play a role in powering the future of AI.

So today I'm joined by two experienced T. Rowe Price
investors, Priyal Maniar, an equity analyst covering North American energy
companies and a co-portfolio manager on our Natural Resources ETF, and Elliot
Shue, a corporate credit analyst covering energy and commodities in our fixed
income division. So, thank you both for joining me today.

Priyal Maniar

It's great to be here.

Elliot Shue

Thank you for having us.

Jackie Fortner

So maybe let's open the conversation with, you know a
high-level overview of the energy space. It's garnering a lot of interest right
now as a sector that has exposure, you know,  not only to emerging themes,
but it’s also a bit of an old school industry and one that we at T. Rowe have
been following for nearly six decades.

So when people think of energy, and oil and gas within that,
they usually think of it as a supply and demand story, but I think we all know
here, there is a lot more at play there. So, to start, can maybe you all just
walk us through how do you think about a sector with complex drivers,
overlapping time horizons, and decipher what matters in how commodity prices
move over time; essentially like what ingredients are feeding into a bull or
bear cycle?

Priyal Maniar

Absolutely. I approach commodity cycles through the cost
curve. It is the most honest reflection of scarcity, capital, and human
behavior. And in the long run, productivity and cost curves are the primary
driver of prices. So what is productivity? It basically measures how
efficiently we can bring new supply online: drilling efficiency, recovery
rates, capital intensity. When productivity rises faster than demand, prices
fall. When it stalls, costs inflate. The cost curve captures the hierarchy of
marginal supply, the price required to incentivize the next barrel of
production. A cycle turns bullish when marginal costs rise. It's often due to
underinvestment, depletion, inflation. It turns bearish when costs fall due to
innovation, excess capital, or new resource plays like shale are discovered in
the 2010s. What do you think, Elliot?

Elliot Shue

Yeah, you can actually see this, if you look at the data. If
you take a chart of the oil price and you zoom out to a view that captures
several decades of history, you will see periods of persistent trends in price,
and those are the bull and bear cycles that are driven by productivity. But the
price isn't always straight up or straight down. If it were, our jobs would
certainly be a little easier. You definitely see price variations around those
trends. And those are short term shocks like geopolitics, supply outages,
economic growth cycles, weather events, and policy shifts. And these can all
drive the price of oil and gas on any given day within that longer term trend.

Jackie Fortner

Well, those are some pretty unpredictable shocks that you're
talking about. So as investors, how do you reconcile the long-term trend and
the short-term shocks, especially because they're probably moving in different
directions?

Elliot Shue

Yeah, you need a healthy respect for both. So I try to
reconcile the two with a solid bottom up understanding of each of my companies,
and then a disciplined valuation framework at both the sector and the company
level. So, is a company's strategy and capital allocation appropriate for the
cycle of the cost curve? If not, that could leave their credit health or their
earnings prospects vulnerable to short-term shocks in either direction. And
then I ask whether the market accurately reflects that bottom up assessment. If
not, then asset prices become more vulnerable to those same short-term shocks.
So, the trend in the cost curve is the tide, and the short-term shocks are more
like individual waves.

Priyal Maniar

I agree we need to be cycle aware at all times, with my eyes
on the structural. Completely ignoring the cyclical generally doesn't yield
good investment returns. Near-term price swings often come from transient
imbalances. These shocks can distort the narrative, and oil can rally in a
fundamentally bearish setup or fall despite tight markets. However, I don't
believe they alter the underlying trajectory unless they impact reinvestment or
productivity  in the longer term. Supply and demand explain the noise.
Productivity and cost curves explain the music, and the real alpha comes from
knowing which one you're listening to.

Jackie Fortner

All right. I wasn'texpecting to get music weaved into a
discussion on energy today, but good metaphor--both of you actually, to kind of
explain how you all navigate through this. So you mentioned, you know,
geopolitics as a key short-term shock. And if we look around the world today,
there are certainly-- it's a world that's more polarized. There are conflicts
between really important commodity producing countries and trading sanctions
that are intended to disrupt global oil supply. We're also, you know, starting
to see indications of an apparent unwinding of production cuts by OPEC+, and
that can threaten to oversupply the market. So how do you assess all these
different crosscurrents at the same time and how they're going to ultimately
impact the energy markets?

Priyal Maniar

Oof. So, geopolitics has always been the wildcard in energy.
I was just in the Middle East this past week, and  it is still confusing
as ever. And the current backdrop is a little different because it's not just
about one conflict or one country. It's about a fractured global order. We're
seeing parallel systems emerge, fragmented trade flows, shifting alliances, and
a growing premium on energy security. For me, the way to make sense of it is to
separate the noise from the structure. In the short term, geopolitics drives
volatility, supply disruption, sanctions, OPEC+ headlines. Those are real. But
they move sentiment more than long term value. In the long term, the bigger
story is the regionalization of supply chains. Countries that are prioritizing
self-sufficiency, building redundancy, and accepting higher costs for
resilience generally points to rising prices for the commodity, right? Like not
just one, for most commodities. This is inherently inflationary. So yes, it is
extremely difficult, it is not completely impossible to assess geopolitics.
However, it's often not by predicting every shock but by asking, does this
raise or lower the marginal cost of reliable supply over the long term?

Jackie Fortner

It takes discipline.

Priyal Maniar

Yeah. For me this geopolitical volatility reinforces why
energy exposure has to be strategic, not tactical. You can't trade every
headline, but you can position for the structural reality underneath it. A
world that's short spare capacity, short investment, and long uncertainty is
what I see when I look out a few years.

Elliot Shue

Yeah, I completely agree. And it's not about geopolitics
necessarily in isolation, but how it fits into all the other pieces that are on
the table. So on the fixed income side, the impact of geopolitical themes and
energy is highly interrelated with the macroeconomic factors that we already
consider when we're looking at global rates and government bond markets.

So for an exporting nation, a higher oil price could mean
higher revenue, potentially an improved outlook for economic growth and the
balance of payments. While for an importing nation, a higher oil price could
mean higher inflation and thus suggest implications for future monetary policy
or that nation's currency. Cycles of oil investment can radically influence
foreign direct investment, growth, borrowing needs, governance, and
geopolitical alignment between countries.

So this can be particularly important for developing
nations. But irrespective of a country's economic maturity or their standing in
the world, the energy cycle has great importance for the bond and the FX
markets in which we invest as a firm.

Jackie Fortner

So with that foundational understanding of commodity cycles
to build on, maybe let's tie the conversation back to the theme of this season,
which is the many transitions going on broadly that impact the energy space.
Energy transition has long been associated with the idea of transitioning away
from fossil fuels. But now you're hearing  a lot more evidence that
actually we might need fossil fuels, at least in some capacity, for longer than
expected to fuel really what’s a hugely energy dependent technology transition,
like the growth of AI. In fact, in an Angle episode from last season Jensen
Huang, the CEO of Nvidia, and our head of global investments, Eric Veiel,
discussed the notion that power and energy themselves are actually the ultimate
limiting factors of AI growth today. So how does oil and gas fit into this
larger investment theme?

Priyal Maniar

That is a great question. The new energy transition isn't
about moving away from fossil fuels. It's about moving toward more energy in
every form. We're just going to need a lot more energy, and we'll need all
forms of energy, to meet the demand. The biggest shift under way isn't just
decarbonization. It's the repricing of reliability in a world that's suddenly
remembered energy has to be there always. Everywhere. The old narrative assumed
a one for one swap-- renewables neatly replacing hydrocarbons. The reality is
very different. Energy systems layer, they don't flip. New demand sources scale
up before old ones fade out. And that's why transitions take decades, not
years. Take AI as an example. AI data centers and electrification are
incredibly energy intensive revolutions. A single hyperscale data center can
consume as much power as a midsize city. Natural gas is increasingly the
pragmatic bridge. It's form flexible and scalable enough to backstop that power
demand.

Elliot Shue

And I think that this idea of an energy transition, it's not
really even a new concept. As Priyal just mentioned in this century in the
U.S., we transitioned the preponderance of our electricity generation from coal
into natural gas, and that's widely viewed as the transitional fuel until we
get to renewables or battery storage or whatever technology emerges in the
decades to come, and one will. To Priyal’s point, the energy systems layer and
overlap. And if you accept that basic premise, oil and gas fits into the larger
theme beyond simply upstream production of hydrocarbons. You need to get those
hydrocarbons out of the ground, but  then you need to get them from point
A to point B, that requires significant infrastructure in the form of
pipelines, LNG terminals, storage, so on and so forth.

The so-called midstream companies that build and operate
this infrastructure are really critical to the energy industry, and they never
drill a single well. Midstream is one of the largest sectors in the corporate
credit universe. And then in the high yield market, an LNG company is one of
the largest single issuers of bonds. So there's a really rich opportunity to
invest in energy away from the stuff that we pull out of the ground.

Jackie Fortner

So despite, you know, the end of energy and the end of
fossil fuel, sounds like you guys have plenty to be working on.

Elliot Shue

We're never bored.

Jackie Fortner

So, you know, maybe for several years, kind of building on
that, there was this narrative in the market that we're approaching kind of
peak oil demand, that there was terminal value risk to fossil fuels as the
prices of these resources declined with supposedly declining demand. So does
this new wave of potential demand change that narrative? Do we still face that
risk, like how do you kind of navigate fossil fuels and clean energy
coexisting?

Priyal Maniar

The idea of peak oil demand made sense in a world where we
assumed growth would slow and technology would displace hydrocarbons in a
straight line. What's changed is the realization that energy demand itself is
compounding electrification, industrial reshoring, AI; and rising living
standards all need more energy, not less. So yes, fossil fuels still face the
long term demand risk, but it's not a cliff. I think it's a slope and a shallow
one. Hydrocarbons remain essential as a system, as a systems backbone, while
low carbon supply scales. The risk isn't terminal value, it's capital
starvation, in my view, not investing enough to manage an orderly decline. We
haven't really invested in oil and gas enough for the past decade since the
shale revolution. So I think that's a bigger risk than us not needing oil in
the near future. Fossil fuels and clean energy can absolutely coexist. They're
not substitutes, they’re  complements in a system that's being rewired for
reliability and sustainability at the same time. The investable insight here is
that reliability itself is being repriced, and the winners across both
hydrocarbons and low carbon solutions will be those that deliver energy that's
affordable, available, and accountable.

Jackie Fortner

And maybe, you know, to tie that back to our initial
discussion of energy market drivers at the start of our conversation, we
touched on productivity waves, how they drive cost curves but also supply into
the market. And so obviously today's backdrop is different from, you know, the
wild, wild west days that everyone thinks of, where companies just kept
spending capital and drilling oil. But what does exploration and company
discipline look like today versus maybe the “drill baby drill” mandate? Is that
something that's even possible today?

Elliot Shue

It's a very different world today than it was 10 or 15 years
ago. We've obviously been in a long period where oil and gas prices have
struggled to gain traction. And in large part, that was because of the
productivity environment that's existed over that time frame. The capital
discipline backdrop is also very interesting because it reflects a long
alignment between equity and credit investors. Companies haven't been rewarded
by the equity markets for aggressive capex and production growth, but they have
been rewarded for reducing debt and strengthening their balance sheets, which
is typically what you would think of as something the credit investors would
like. As far as “drill, baby, drill,” in my view it's a very tall order. The
Federal Reserve Banks of Dallas and Kansas City publish quarterly energy
surveys, which suggest that the average U.S. E&P requires an oil price in
the mid $60s to profitably drill a new well. To grow aggressively, they would
require a price somewhere in the mid $80s.

So that's sort of a live look at the impact of productivity
cycles. As we're recording this, oil is around $61 a barrel. So if you believe
the data from the Fed surveys, the market requires either a stronger price
signal to produce more meaningfully or it needs a new breakthrough in
technology to do the same at a lower price.

Jackie Fortner

So, with that thought then, are there promising new
technologies on the horizon that could boost productivity in the future and how
far off might those be?

Priyal Maniar

There is always innovation happening in energy. And I'm
always on the lookout for these new technologies that can unlock further
productivity gains. What I've learned over the years is to not bet against the
industry. They always come up with something, but what has happened is even
innovation happens in waves. Unlike the 2010s, when shale technology reset the
entire cost curve, the recent gains are more incremental than transformational.
And on a basin county basis, they're plateauing. In the near-term, productivity
improvements will likely come from data and process optimization like better
subsurface analytics, real time drilling automation, and AI driven production
management. These tools can squeeze more out of existing assets, improve
recovery rates, and reduce downtime, but  on the margin. However,
productivity and technology advancements also happen in really long cycles as I
mentioned. Periods of rapid innovation are often followed by periods of
stagnation, or innovation that just controls the rise of the cost curve as
worsening geology takes center stage. I believe technology is still advancing,
but it's on, it's no longer lowering the cost curve, it's mostly just slowing
its rise.

Jackie Fortner

So you guys have taken us through a really technical
discussion, given us lots of great details. So I'm going to humanize this a
little bit. I feel like I am the last person on the planet who hasn't seen the
show Landman, which is apparently based in the oil fields of West Texas. But
I'm still going to wager a guess it probably doesn't exactly capture what it's
really like to be out there in the field. So, I mean, you guys, you know, a
huge part of your roles is boots on the ground research and observation. You're
not just sitting at your desks all day. So maybe kind of as a parting gift, can
you take, maybe take us there for a minute and bring our listeners on site with
you to maybe one memorable bit of travel kind of related to your work?

Elliot Shue

Yeah. So one that, having watched Landman, one that sticks
out to me. I was once in northern Alberta to visit an oil sands operation. And
northern Alberta is sort of the Canadian equivalent of West Texas. It's very
empty. It's just colder. And my tour guide was kind of the Canadian version of
Billy Bob Thornton’s character in Landman. And as we were driving around, we
drove past one of the upgrading facilities that they used to process the oil.
And these emit a very strong and very distinct sulfurous odor. You can't help
but notice it, but my tour guide was clearly used to it. And he just sort of
shrugged it off and said, that's the smell of money, which strikes me as a line
that could have been straight out, straight out of Landman.

Priyal Maniar

That's a great story. Well, I'll highlight one of the, one
of my coolest trips that I've ever been to is, is the offshore floating
production vessel in Guyana. And this is a couple of years ago. And as the
world was reopening post-Covid, this was one of the initial investor trips to
go down to Guyana. And it was, I was a new mother at that time, and my baby was
five weeks old, but I couldn't give up on the opportunity to go down to Guyana.

Jackie Fortner

That's some dedication Priyal.

Priyal Maniar

So I got I took my five week old baby, picked  his
passport, emergency passport from the State Department. I had a flight ticket,
got, show up at the State Department, get his passport on the way to New York,
stop at the Guyanese embassy and get our visas, and then go on the plane, take
a redeye down to Georgetown, Guyana. And I did go on the FPSO. He did not go
with me because you have to go in a helicopter and need training in case the
helicopter goes down; very scary. I don't recommend anybody go through that
training. They actually drown you in a big swimming pool, and you have to get
out of it as if the helicopter crashed in the ocean. So, I would not recommend
that.

Elliot Shue

Recommend that with a 5-week old.

Priyal Maniar

Yes, yes. So he stayed in the hotel with his older brother
and father while I went out to the FPSO, and wow, it’s an engineering marvel
out there.

Jackie Fortner

That's really cool. Well, you know, I guess, thank you both
for spending the time here today for, you know, walking us through the backdrop
for the energy landscape and how we can just think about all these
transformations that are happening in the market and maybe how to contextualize
it as we think about what that means for the space going forward. Thank you all
very much.

Priyal Maniar

Thank you.

Elliot Shue

Thanks a lot. It's been great.

Jackie Fortner

And to our listeners, thank you again for listening to The
Angle. We look forward to your company on future episodes. You can find out
more information about this and other topics on our website. Please rate and
subscribe wherever you get your podcasts.

The Angle. Better questions, Better insights. Only from T.
Rowe Price

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